Why Small-Cap Companies are Essential to Market Prosperity

Joel Anderson |

Times are tough for the small-cap companies of America, and they have been for a while. The capital markets that are so essential to growing an emerging company have been repeatedly disincentivized from offering support, through everything from the wrong-sized regulations of Sarbanes-Oxley to the decimalization of tick sizes to the Spitzer Decree. To be sure, none of this was intentional. Each of these reforms made sense for the large- and mega-cap companies out there, but their existence has nonetheless made life for small-caps that much harder.

Of course, the lack of a welcoming climate for small-cap companies on Wall Street hardly means the people working there can pack up shop and call it a day. Small-cap companies are among the primary drivers for job growth in this country. They power innovation and create new wealth in ways that the larger dinosaurs out there simply can’t compete with. For every IBM (IBM) and Microsoft (MSFT) out there, there’s a dozen young tech companies with the capacity to revolutionize the markets and create prosperity for investors and the broader economy alike.

That’s why equities.com is committed to offering support for the market’s smaller players by building the sort of business community where small- and micro-cap companies can thrive, connecting investors looking for opportunities with companies looking for support. On December 18, we’re kicking off our annual Small-Cap Stars Conference at the NASDAQ MarketSite in New York - precisely the sort of opportunity for investors and companies alike to build the relationships that can allow them to create lasting prosperity.

Lack of Institutional Support has Crushed Flow of Capital to Small-Cap Companies

It’s not hard to see why the changes to the market that have squeezed out small-caps has happened. They are large-scale reforms for large-scale problems with large-scale companies. In the wake of Enron’s collapse and the Dot-com bubble, something had to change.

But, whatever the intent, the reality has been that the institutional support that once provided the underpinnings for a thriving, innovative small-cap market has rapidly eroded. Investment banks and broker dealers just don’t find the profit motive for underwriting small-cap IPOs or committing resources to helping create enhusiasm for those companies post-IPO that once existed.

In 1991, IPOs raising $50 million or less represented 70% of total IPOs. That figure plunged all the way to 10% last year. And it’s no wonder, as all of the support from underwriters, brokers, and analysts has completely evaporated after these entities found it increasingly difficult to make any money off of trading small-cap stocks. And market support after the IPO remains extremely limited. While investment banks and research firms commit hordes of analysts to breaking down every detail of heavily-traded large- and mega-cap companies, the lack of commissions means doing the same for the smaller companies out there just doesn't make economic sense for them anymore.

Changes in the Marketplace Don't Mean Changes in Opportunity

The thing is, even if underwriters and brokers don’t see as much opportunity in small-cap investing, that doesn’t mean that the rest of us shouldn’t. Small-cap companies provide a wide range of advantages to both the investing public and to the economy as a whole.

Companies that are small-cap or smaller represent some 80% of all listed companies, and small businesses in America are responsible for almost 20% of job growth. Simply put, while blue-chip stocks are typically looking to shave expenses and downsize, it’s the growing companies that are creating new markets, engineering bold new technologies, and creating new job opportunities as they constantly search for talent to feed their growth. That's especially true post-IPO, when these small firms are flush with cash and looking to staff up and hit the ground running post-IPO.

Investors also get more back from investments in the small-cap markets. While risk increases, that’s the price paid for a massive increase in opportunity. Peter Lynch breaks down why small-cap stocks are so appealing in his book One Up on Wall Street, detailing how the overly-analyzed blue chips tend to trudge along with a steady if plodding pace. The opportunity for any investor to find something on the verge of major growth is slim to nil in this case, what with the dozens of analysts and hundreds of mutual funds picking over the options.

Lynch, though, saw tremendous opportunity in small companies that hadn’t been noticed by the institutional investors to that point. Finding one of his classic “ten baggers” was only possible when looking at the companies that were entering their growth cycle, not leaving it. Even Warren Buffett, he of the blue-chip dividend investing, also makes a point of picking through smaller companies with major growth potential to supplement his safer income stocks.

Building Relationships Key to Continued Small-Cap Market Growth

Finding ways to put more money in the hands of fast-growing companies just makes sense. Those are the companies that are hiring, that are creating the sort of strong jobs our economy needs. And putting those companies in contact with the investors ready to take the plunge also makes a lot of sense, creating opportunities for wealth creation on both sides of the equation.

That’s where equities.com can be an essential factor a brighter future for this underserved portion of the market. We’re committed to highlighting those small-cap companies that deserve more attention with products like our Small-Cap Stars system. The Small-Cap Stars is our proprietary system for identifying the fundamental profile small-cap companies in each industry had prior to periods of explosive growth and then picking out those companies that currently feature a similar profile. And any investor can make use of our E.V.A. Reports to dig into the finances of small-cap companies to do their own research and analysis.

Finally, our Small-Cap Stars Conference can be an essential piece to righting some of the wrongs done to our small-cap market over the last 20 years. Building relationships through face-to-face meetings and presentations is precisely how retail investors and small-cap companies alike can overcome the lack of support their segment of the market is getting from the market makers out there.

Because neglecting a wide swath of American markets that can spark job growth and bolster your portfolio just because they aren’t profitable enough to investment banks and broker dealers just doesn’t make any sense. Those market makers may not have the same opportunities that they used to in supporting those stocks, but the opportunity for prosperity is still there for investors, and it’s time to get back to seizing it.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
IBM International Business Machines Corp 166.52 1.16 0.70 3,133,318
MSFT Microsoft Corporation 61.97 0.96 1.57 26,664,330

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